Rebalancing towards US Agg

Each month, the SSGA Investment Solutions Group (ISG) meets to debate and ultimately determine a Tactical Asset Allocation (TAA) to guide near-term investment decisions for client portfolios. Here we report on the team’s most recent discussion.

Macro backdrop

Oil prices have spiked amid the Middle East conflict, with WTI hovering around $100 per barrel. Logistical shipping constraints and infrastructure damage are tightening global fundamentals. Higher energy prices have prompted downgrades to growth expectations, as rising gasoline costs feed through to broader inflation and weigh on consumption.

That said, there is reason to expect the US economy to remain resilient. During the last extended period of elevated oil prices from 2011 to 2014, WTI averaged roughly $95 per barrel while US real GDP growth averaged about 2%. While the comparison is imperfect given today’s different point in the cycle, it remains instructive. The earlier recovery from the global financial crisis was supported by near-zero policy rates and lower inflation, whereas interest rates are materially higher today. However, unemployment is currently just above 4% versus more than 6% during that period, and wage growth, though moderating, remains stronger than in the early 2010s, when it averaged about 2%.

More broadly, the US and global economies have absorbed multiple shocks in recent years—from the Russia–Ukraine war and aggressive monetary tightening to elevated inflation and tariffs—while continuing to generate growth. As a result, while downside risks increase the longer the conflict persists, higher-for-longer energy prices are unlikely to derail economic expansion outright, even if growth moderates.

Reflecting these dynamics, we have modestly downgraded our US growth forecast to 2.3% from 2.4% and raised our inflation outlook to 3.0% from 2.8%. We have also reduced expected rate cuts this year to 50 bps and pushed the first cut to September. Despite these adjustments, we remain cautiously optimistic.

A resolution to the Middle East conflict would support an economy that remains positioned for growth. Recent improvements in labor market diffusion, declining unemployment claims, and expansionary PMIs are encouraging, even as small-business optimism has softened and higher gasoline prices pose a near-term headwind. Importantly, tailwinds

from earlier central bank rate cuts, fiscal support from the OBBA, strong corporate profits, and higher tax refunds should help cushion the impact on consumption.

Overall, uncertainty remains elevated, and the outlook for growth and inflation is highly dependent on the trajectory of the Iran conflict. However, absent a prolonged war, we continue to expect solid economic growth. 

Directional trades and risk positioning

When evaluating the current market environment, we see a continued deterioration in overall support for risk assets. Risk appetite had already been softening for much of the year and turned modestly negative in March, as reflected in a further increase in our Market Regime Indicator (MRI).

While our intermediate-term outlook for equities remains positive, near-term momentum has shifted toward weaker forecasts, a trend that persisted through March. Although a two-week ceasefire has recently been agreed, uncertainty remains elevated given the fragile geopolitical backdrop. Together with the negative shift in our quantitative signals, these dynamics led us to reduce equity exposure, lowering both total portfolio risk and active risk positioning.

Risk appetite deteriorated further in March as our MRI continued to trend higher, signaling a broad shift toward more risk-averse conditions. The escalation in the Middle East materially increased uncertainty and intensified concerns around global growth. Rising energy prices fueled broader inflation concerns, prompting a sharp repricing of expectations from the Federal Reserve (Fed) as markets removed forecasts for near-term rate cuts.

These concerns were reinforced by the Fed’s latest Summary of Economic Projections, which pointed to higher inflation pressures, stronger growth, and limited easing ahead, further entrenching a “higher for longer” narrative. Similarly, while both the Bank of England and the European Central Bank held policy rates steady, accompanying communications leaned hawkish.

From a model perspective, the recent deterioration in our MRI has been driven primarily by two factors. First, widening sentiment spreads have moved firmly into risk-off territory, signaling a clear pullback in investor confidence. Second, implied volatility has risen across all three indicators, with equity volatility in particular reaching extreme levels.

Elsewhere, risk-support indicators have stabilized at lower levels but continue to point to a modestly risk-off backdrop. Taken together, these dynamics underscore a broad-based weakening in our model and suggest a less favorable environment for risk assets.

For equities, the weaker forecast reflects a combination of factors. While there remains a basis for cautious optimism, our model now points to more muted expected returns. Only two components are outright negative: valuations and macroeconomic conditions. Beyond this, a broad moderation across several factors has weighed on the outlook. Weaker market performance in March pulled our short-term price momentum signal lower, while earnings expectations and balance sheet health, though still supportive, have eased and now sit below the stronger levels seen in late 2025. Overall, the equities outlook remains positive, but the breadth of deterioration across inputs has reduced their relative attractiveness compared with earlier in the year.

Fixed income markets were not immune to the broader sell-off in March, but our model continues to forecast modestly positive returns. We expect a slight decline in yields driven by elevated risk aversion, while longer-term trends still point to lower rates, helping to offset stronger commodity price momentum. We also anticipate limited change in the slope of the yield curve, as momentum and persistent inflation pressures imply a flatter curve, counterbalanced by ongoing signs of softer economic activity.

Within credit, the outlook has deteriorated, with most monitored factors pointing to wider spreads. Weaker equity momentum following the March sell-off, elevated implied equity volatility, and higher risk aversion all suggest a more challenging environment for spread assets.

From a positioning standpoint, we implemented a modest reduction in equities, bringing the portfolio back to a neutral allocation. Proceeds from the equity sale, together with the redeployment of our existing cash position, were invested in US aggregate bonds, modestly increasing fixed income exposure. Despite this adjustment, the overall bond exposure remains underweight, while the portfolio continues to maintain targeted allocations to gold and broad commodities. 

Relative value trades and positioning

Within equities, our regional forecasts have weakened modestly, though relative rankings remain largely unchanged, with a continued preference for US and emerging market equities over non-US developed markets.

In the US, sentiment indicators across sales and earnings, along with quality and macroeconomic factors, continue to provide support. However, the outlook for US small-cap equities has deteriorated more meaningfully, driven by weaker macroeconomic support and relatively softer balance sheet health, reinforcing our preference for large-cap equities.

Outside the US, equities have been more adversely affected by the Middle East conflict due to greater reliance on imported energy. The outlook for Europe remains weighed down by weak momentum and poor sentiment. Pacific equities exhibit some positives, including improved price momentum and strong sentiment signals, but weaker valuations and a deterioration in macroeconomic factors have pushed the regional forecast lower. Against this backdrop, we implemented modest reductions in Pacific equities and US small-cap equities, reallocating proceeds to US large-cap equities. As a result, Pacific and US small-cap allocations were returned to benchmark levels, while overweight positions in US large-cap and emerging market equities were maintained.

Within fixed income, we executed a modest rotation out of non-US government bonds and into long-duration US Treasuries. This shift reflects more favorable expectations for US rates alongside a weakening outlook for international government bonds. While long-dated US Treasuries benefit from our forecast for lower yields, our model anticipates rising yields outside the US, as higher energy prices have revived inflation concerns—particularly in energy-importing economies. As a result, the level acceleration factor for non-US bonds has moved higher, indicating upward pressure on yields. These adjustments leave us modestly underweight in non-US government bonds while extending duration exposure within US Treasuries.

Within equity sectors, health care stands out, supported broadly across factors, with improving sentiment and strengthening price momentum lifting the sector’s outlook for April. Industrials do not stand out along any single dimension, but broad-based support across most factors, excluding valuations, continues to justify our allocation.

Communication services remains well supported across most inputs. However, a deterioration in the macroeconomic factor, alongside more moderate price momentum and sentiment, has lowered the sector’s ranking, though it remains among our top-four allocations. Energy rounds out our preferred sectors, benefiting from the recent rise in energy prices, with sentiment turning positive on improved earnings expectations and price momentum continuing to strengthen.

To see sample Tactical Asset Allocations (TAA) and learn more about how TAA is used in portfolio construction, please contact your State Street relationship manager.